The Auditor’s Superpower: Telling the Story through CAMs and the Power of One Degree

Remarks as prepared for delivery

Good morning and thank you John [Treiber] for the kind introduction and for the invitation to participate in Deloitte’s 2024 Professional Practice Director Seminar. It is a pleasure to be with you and your colleagues this morning and contribute my thoughts to your conference and discussion. I always appreciate the opportunity to talk about the ongoing work and initiatives of the PCAOB. Of equal importance, I welcome the chance to emphasize the significance and the important service of individual auditors, audit firms, and the auditing profession to protecting the investing public, our capital markets, and society as a whole.

Before I continue, please know that my remarks this morning reflect my individual views as a Board Member, and do not necessarily reflect the views of the full Board, my fellow Board Members, or the PCAOB’s dedicated and hardworking staff. 

I have been looking forward to being with you today, both to hear your questions and comments, and for the opportunity to reflect on the vital role this audience plays. As members and leaders of Deloitte’s Professional Practice Network, you have a unique and weighty responsibility both within the firm and, more broadly, in the auditing profession. You are recognized as talented accountants and auditors with deep technical expertise and years of experience, which allow you to assist in establishing the firm’s accounting and auditing policies and ensuring compliance. You also assist audit engagement teams working through numerous challenging, complex, and judgmental issues and ultimately strive to maintain high audit quality that will protect investors.

I also want to recognize the members of the firm’s Audit Quality Advisory Council who are with us today. Your independent insights and perspectives, derived from your broad array of current and past leadership roles and experiences, are a critically important voice.

As I was contemplating my remarks for this morning, I was envisioning the all-important role of the staff auditor. The individual who, in many instances, has the first, and maybe only, direct interaction with the company’s management when executing audit procedures about a control or transaction. Who first identifies and develops questions and then has follow-up questions regarding the purpose of a given transaction or journal entry. Who notices an inconsistency in an explanation or possibly an odd reaction to a question. The staff auditor’s ability to exhibit due care and professional skepticism underpins the success of the entire audit.

The efforts of the staff auditor are intangible and fragile, and must be nurtured and actively stimulated across all levels of the firm. These individuals need both the technical knowledge and confidence to pause and identify matters that necessitate inquiry and further investigation. Without both of these traits, audit quality will be compromised and undermined.

I am pleased that firm culture has been a recent focus at the PCAOB. Our inspections division is in the midst of a culture review initiative to better understand how firms’ tone at the top and culture play a role in audit quality. And QC 1000, A Firm’s System of Quality Control, recently approved by the SEC, specifically emphasizes the importance of culture on the system of quality control through its inclusion as an additional risk consideration.

Again, the role of the Professional Practice Network is critical here. Your shadows within the firm are large, and rightfully so. I suspect in many instances your voice provides backing, encouragement, and support to engagement teams when they face difficult discussions with management. In addition to supporting individual audits, you play a large role in establishing and maintaining the firm’s culture, which is vitally important.

Earlier this year, I discussed the characteristics or the “DNA” of a successful financial statement auditor.¹ I suggested that the four key attributes for an auditor include:

• a commitment to investors and the public interest;
• a drive to obtain an in depth understanding of the company’s business, operations, and strategy;
• a dedication to lifelong curiosity; and
• an obligation to professional skepticism.

These four elements, when woven together, I believe capture the essence of a successful auditor. They establish a frame of reference to ensure not only a successful financial statement auditor, but also that audits are executed with high quality across a firm.

As I have continued to reflect on these characteristics, I have thought more about how that essence expresses itself. I want to offer for your consideration the feature of a successful financial statement auditor that all of these attributes combine to produce. I posit that this may actually represent an auditor’s superpower. But, first let me provide some context.

Importance of a Single Habit

In October 1987, Aluminum Company of America’s (or Alcoa) new chief executive officer, Paul O’Neill, held his first press conference with Wall Street investors and stock analysts.² At the time, it was recognized that Alcoa’s management had previously made a number of missteps, so the audience was eagerly awaiting the new CEO’s plans to improve the company’s performance and stock price. Without question, the expectations for the press conference and Mr. O’Neill were high.

However, Mr. O’Neill mentioned neither performance nor profit. Rather, he focused his remarks exclusively on worker safety and the need for the company to reduce the number of worker injuries. Mr. O’Neill very clearly stated that he intended “to make Alcoa the safest company in America.” And, he added that “I intend to go for zero injuries.”

As you might imagine, this was not what the audience expected to hear. When audience members asked questions about the company’s financial metrics such as inventory levels and capital ratios, Mr. O’Neill’s response was a jarring “I’m not sure you heard me.” He continued, “If you want to understand how Alcoa is doing, you need to look at our workplace safety figures.” As he was talking, certain audience members stampeded out of the room to be the first to find a pay phone to tell their clients to sell Alcoa stock. Many thought Mr. O’Neill was going to kill the company.

As time passed though, Mr. O’Neill’s laser focus on worker safety was viewed as ingenious. The centering of worker safety caused the most radical realignment in Alcoa’s history. It transformed the entire company, across all levels from union workers to plant managers to the executive ranks. By the time Mr. O’Neill retired in 2000, these changes had led to net income being five times higher, with a $27 billion increase in Alcoa’s market capitalization, compared to before he arrived. Furthermore, Alcoa was one of the safest companies in America.

I mention this episode not only because it is an incredibly interesting story in the history of American business, but because it clearly demonstrates how focusing squarely on one priority can change a large and complex organization. Mr. O’Neill later said, “I knew I had to transform Alcoa. . . . So, I decided that I was going to start by focusing on one thing. If I could start disrupting the habits around one thing, it would spread throughout the entire company.” He was right.

The Auditor’s Superpower

This brings us back to the superpower of an auditor. At its most simple level, a financial statement audit tells a story. It tells a story of the company’s activities – how it executed on its stated strategy and goals, transactions, revenues, expenses, assets, and liabilities. While the numbers are certainly important, telling the story goes beyond the numbers. The independent financial statement auditor has a special and matchless position to see and comprehend the company in ways others cannot. I submit that the auditor’s superpower is this: the power of telling the story.

Because the auditor brings an objective, independent, and skeptical mindset, their ability to tell the story is different from that of company management and all others. This ability or characteristic is what underpins the auditor and the auditing profession’s ultimate product – trust.

The public trusts the auditor to discern the complete, accurate, and informative story of a company, and to issue a corresponding opinion. Once the public knows that it can trust the story a company’s financial statements are offering, that story helps the public understand where the company has been, where it is likely to go, and so informs investment decisions across the capital markets. None of this can happen without the trust imbued by the audit.

As you consult and interact with engagement teams and individual staff auditors, encourage them to tell the story. If every member of the engagement team, from the intern to a partner with decades of experience, focuses on telling the story, I assert it will lead to improved audit quality, and quite possibly make for a more gratifying audit experience and career. Just as with Alcoa, a single focus can be wholly transformative. I welcome any thoughts you may have on this.

In my remaining time, I want to focus on two areas. First, the PCAOB’s standard-setting agenda. Second, and keeping with the auditor’s superpower of telling the story, I want to talk about the importance and value that critical audit matters (or CAMs) provide to investors and the other users of financial statements.

The PCAOB’s Standard-Setting Agenda

The PCAOB continues apace in our ambitious rulemaking and standard-setting agenda. I want to highlight some of our recent efforts in this area, starting with QC 1000 and then moving on to other recently approved and proposed standards.³

QC 1000⁴ represents a milestone for the quality control system under which public company audits are performed. The standard was designed to offer a proactive, risk-based approach to quality control, with certain mandated quality objectives to ensure firms appropriately design, implement, and operate their quality control system. The changes captured in the new standard have been designed to strengthen the systems supporting a registered firm’s audits of public companies, ultimately in the aim of protecting investors and supporting the public interest.

I want to touch on two of these features. First, as I mentioned, the standard specifically emphasizes the importance of firm culture on the system of quality control through its inclusion as an additional risk consideration. The standard requires firms to obtain an understanding of the culture of the firm, and the extent to which a culture of integrity and a commitment to audit quality is promoted within the firm and embraced by firm personnel across all levels. Through this requirement, the PCAOB is sending a strong message that culture is critical to the system of quality control and is not limited to the tone at the top.

Second, firms that issue audit reports for more than 100 issuers in a year will now be required to establish an external quality control function (or EQCF) to add oversight of their governance structure. The release includes certain basic requirements for the function, but also offers firms flexibility to tailor the role to their own needs, and I am looking forward to seeing what they choose to develop. 

Last month, the SEC approved new standard AS 1000, General Responsibilities of the Auditor in Conducting an Audit, approved amendments to PCAOB Rule 3502, which governs contributory liability, and approved other amendments related to technology assisted analysis.

AS 1000 and the related amendments reframe the auditor’s fundamental obligations: those that address the general responsibilities of an auditor in the audit.⁵ Instead of changing or altering the auditor’s responsibilities, the standard and amendments serve to streamline and clarify auditor responsibilities while also enhancing the useability of the standard by making it easier to read, understand, and apply.

Rule 3502 has been amended to hold accountable those associated persons who directly and substantially contribute to their firms’ violations when they knew or should have known their actions would do so.⁶ The change will allow the PCAOB to better hold responsible actors accountable and thus ensure the profession maintains its vital position of trust.

As for the tech amendments,⁷ nowhere can the need for modernization of our standards be seen more plainly than in the face of the constant march of technology. These principles-based amendments account for how automation, data analytics, and other processes are currently used in audits, while retaining enough flexibility to account for their inevitable evolution in ways we cannot anticipate.

We also have a number of rules and standards that were recently proposed with next steps pending. Firm and engagement metrics, for example, aims to offer insights into the work of audit firms with informative metrics that would aid investors, audit committee members, and other stakeholders in their decision making.⁸ The firm reporting proposal focuses on enhancing firms’ disclosure of information about firms’ governance, finances, and, to the extent applicable, network information, as well as more timely and detailed reporting on certain events.⁹ I was pleased to support both of these proposals, and glad to see how much they were engaged with during the comment period.

Finally, we currently have two research projects, one focused on data and technology and the other on CAMs, which I will turn to now.

Critical Audit Matters

CAMs represent a real and tangible example of where an auditor can tell the story.¹⁰ During my time at the PCAOB, an area of focus for me has been identifying ways to increase transparency of both the PCAOB’s work as well as the external audit process for investors, audit committees, and other interested parties. I believe CAMs are an excellent example of this, and I recently delivered remarks on this topic.¹¹

CAMs are a vital element of the audit and a way that auditors can not only increase the relevance of the audit but also provide their unique insights into the audit to investors which ultimately increases trust. While I am pleased that CAMs are being researched by the staff of the Office of the Chief Auditor, and continue to be a focus of our Investor Advisory Group (IAG), I remain troubled by the declining number of CAMs across all audits. I look forward to the recommendations from our staff and our IAG that may help to increase the number of CAMs.

In this regard, I was extremely pleased and reassured by the results of a recent Center for Audit Quality (CAQ) survey.¹² The survey included 100 U.S. institutional investors and was conducted in July of this year. Let me highlight a few of the findings:

• 92% of investors use CAMs when they make investment decisions;
• most investors read the CAMs section in the auditor’s report, with 78% reading it always or often;
• and 93% of investors say that CAMs play an important role in their decision-making analysis of a potential investment.

Of equal importance and telling is that the survey found that 58% of investors would prefer to see more CAMs in an auditor’s report.

The survey results are powerful and clearly illustrate the importance of CAMs to investors and the clear value the auditor can bring by telling the story.

As we rapidly approach the year-end audit season, and as you interact with engagement teams, I strongly encourage you to keep CAMs as an area of focus and challenge engagement teams to keep CAMs top of mind to ensure all matters that meet the definition of a CAM are carefully considered for inclusion in the auditor’s report. I urge you to tell the story.

The Power of One Degree

As I begin to close, in addition to telling the story, I want to suggest you consider the power of “one more degree,” an idea developed by Sam Parker and Mac Anderson.¹³ As you probably know, at 212 degrees water boils, and boiling water creates steam. Steam has the power to move turbines that create electricity and can power locomotives. Water at 211 degrees, however, is still hot water. The effort to raise the temperature of water by only one extra degree is the difference between something that is simply hot, and something that can generate enough force to power a locomotive.

I think the relevance of that extra degree to the audit process is self-evident. Pursuing that one more degree can be as simple as the auditor asking one more question of management, or following up on a lingering question. It could be the engagement partner having another meeting with the company’s chief executive officer and chief financial officer about a financing transaction, or the engagement quality control reviewer asking one more question of an engagement team. Taking the time for that one additional question – to “pull the thread” – may ultimately uncover an accounting error, lead to a material audit adjustment, or even identify a fraud. That is the power of one more degree. The challenge, of course, is having the fortitude to keep going when you do not know whether you are at that threshold, and the courage to be comfortable asking the uncomfortable question. Just because this lesson is simple, does not mean it is not hard.

As leaders, you are well positioned to cheer on staff auditors to expend the effort for that one extra degree. I believe that the firm as a whole should strive to have a culture of “one more degree,” so auditors across all levels feel emboldened to pursue this incremental degree, to ask that one additional question, and follow it where it leads. That is what distinguishes a high-quality audit and that is what investors expect.

Conclusion

In closing, I want to leave you with a few key takeaways.

• First, the importance of the auditing profession cannot be emphasized enough. The auditing profession is vibrant, resilient, and noble, and not only serves investors and the capital markets, but society as a whole. The auditing profession helps ensure our way of life.
• Second, the auditor’s superpower is the ability to tell the story. This focus may lead to other changes to improve audit quality. I encourage all auditors to celebrate this superpower.
• Third, I encourage you to always keep CAMs top of mind. Not only do investors want and use them, they will continue to ensure the relevancy of the audit and will tell the story which collectively adds trust to the audit and the capital markets.
• And lastly, never underestimate the impact of asking one additional question – to add one more degree.

Admiral William H. McRaven said “Everyone wants to be part of something special.”¹⁴ Regardless of one’s years of audit experience, being a financial statement auditor and a member of the auditing profession is something special and not to be taken for granted.

Thank you for your attention and, John, I am pleased to take your questions.